How indispensable is China?

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Last week's Economist had an interesting piece looking at the world's dependence on the Chinese economy. It provided a sample of statistics and factoids highlighting just how important China now is – last year China accounted for about 46% of global coal consumption and a similar share of the world's zinc and aluminium, and got through twice as much steel as the EU, US and Japan combined; this year it's forecast to account for more than a quarter of world growth and buy more mobile phones than the rest of the world put together.

But the piece goes on to caution that it's still possible to over-estimate China's importance. For example, while China is now the largest export market for a range of economies (including of course Australia), for most countries this still represents only a modest contribution to GDP:

Moreover, since, in an accounting sense, what matters for growth is net exports, which take into account large Chinese imports, the actual effect is even smaller.

Of course, and as the article recognises, the export numbers only pick up part of the China effect: there are, for example, multipliers from export earnings, through knock-on effects on investment, consumer spending, and government revenues.

It will come as no surprise that Australia makes for an interesting case study of the wide range of these channels. Not only does China influence our economy directly through its role as our most important export market, but it is also a major driver of our terms of trade (the ratio of our export to import prices), currently at their highest level since the 1950s Korean War wool boom:

This, in turn, has contributed to a boom in mining investment which has turned Australia into one of the world's few high income, high investment economies.

The China effect is also being felt in our share market – in particular through its impact on the profitability of our mining companies – and in our stronger exchange rate. These effects on asset prices are both direct (higher earnings for resource companies, for example) and indirect: the A$ is often touted as a proxy for the non-convertible RMB, for example. More recently, the China effect has started to make itself felt in our direct imports of capital from China.

A recent speech by the RBA's Philip Lowe noted that these developments were showing up in an increased correlation between Chinese and Australian economic growth, which shows that 'what happens in the Australian economy is now more dependent upon what happens in China than has been the case at any time in our past':

Finally, I've posted before on the economics of confidence, and – while hard to quantify – it seems likely that the China effect also operates through this channel. It's now commonplace to hear that one reason Australia has sailed through the GFC is our links to the Chinese economy. It's also widely understood that China has been driving the mining boom. So widespread is the assumption that China is boosting Australian prosperity that I'm pretty sure a strong Chinese economy plays at least some role in supporting business, consumer and investor confidence more generally – that is, over and above the direct effects listed above.

None of which is to say that China is 'indispensable' to Australia. But it certainly does suggest that our economic vulnerability to something going badly wrong with the Chinese economic story is now high and rising.